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Monday, 6 February 2012

Capital Maintenance in Units of Constant Purchasing Power is authorized in IFRS

Capital Maintenance in Units of Constant Purchasing Power is authorized in IFRS

Capital Maintenance in Units of Constant Purchasing Power is authorized as an alternative to Historical Cost Accounting in IFRS at all levels of inflaiton and deflation in the original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)] which states:

'Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.'

IAS 29 is - currently - still required to be applied during hyperinflation.

Any entity implementing IFRS during low inflation, high inflation and deflation can thus immediately change over to capital maintenance in units of constant purchasing power (CIPPA).

Capital maintenance in units of constant purchasing power is a departure from Historical Cost Accounting. It is a fundamentally different accounting model than HCA, i.e. financial capital maintenance in nominal monetary units.

Capital maintenance in units of constant purchasing power automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation - ceteris paribus - whether they own any revaluable fixed assets or not.

The attributes of capital maintenance in units of constant purchasing power are:

1 The real value of capital is always equal to the real value of net assets.

2 The capital concept to be implemented: Constant purchasing power capital.

3 The capital maintenance concept to be implemented: Financial capital maintenance in units of constant purchasing power in terms of a Daily CPI at all levels of inflation and deflation.

4 The stable measuring unit assumption is never implemented under capital maintenance in units of constant purchasing power in terms of a Daily CPI.

5 Monetary items are units of money held and items with an underlying monetary nature which are substitutes for units of money held.

6 Non-monetary items are all items that are not monetary items

7 Non-monetary items are sub-divided in:

(a) Variable real value non-monetary items and

(b) Constant real value non-monetary items.

A variable real value non-monetary item is a non-monetary item with a variable real value over time.

A constant real value non-monetary item is a non-monetary item with a constant real value over time whose value within an entity is not generally determined in a market on a daily basis.

8 Daily measurement is required of all items in terms of:

(a) a Daily Consumer Price Index or monetized daily indexed unit of account, e.g. the Unidad de Fomento in Chile, during low inflation, high inflation and deflation and

(b) in terms of a relatively stable foreign currency parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate during hyperinflation. Hyperinflation is defined in IAS 29 as cumulative inflation being equal to or approaching 100 per cent over three years, i.e. 26 per cent annual inflation for three years in a row.

Measurement

9 Historic and current period monetary items are required to be inflation-adjusted on a daily basis as detailed above. When they are not inflation-adjusted on a daily basis during the current financial period then the net monetary loss or gain as defined in IAS 29 is required to be calculated and accounted. All monetary items of the fiat currency created within an economy by means of fractional reserve banking except actual bank notes and coins of this currency can be inflation-adjusted on a daily basis within an economy. This would remove the total cost of inflation (not inflation) from the entire money supply except from actual bank notes and coins which generally make up about seven per cent of the money supply in advanced economies.

10 Current period variable real value non-monetary items are required to be measured on a daily basis in terms of IFRS excluding the stable measuring unit assumption and the cost model in the valuation of property, plant, equipment and investment property after recognition. When they are not valued on a daily basis in terms of IFRS as qualified, then they as well as historic variable real value non-monetary items are required to be updated daily in terms of a Daily CPI as indicated above. Current period impairment losses in variable real value non-monetary items are required to be treated in terms of IFRS. They are constant real value non-monetary items once they are accounted. All accounted losses and profits are constant real value non-monetary items.

11 Historic and current period constant real value non-monetary items are always and everywhere required to be measured in units of constant purchasing power in terms of a Daily CPI as detailed above.

12 The calculation and accounting of the net constant item loss or gain is required when constant real value non-monetary items are not measured daily in terms of a Daily CPI in units of constant purchasing power.

13 Once an entity has started financial capital maintenance in units of constant purchasing power in terms of a Daily CPI, it is required to continue with that model at all future levels of inflation and deflation.

14 Entities in economies with inflation rates below 10 per cent per annum or cumulative inflation over three years below 26 per cent should be very strongly encouraged to implement financial capital maintenance in units of constant purchasing power as proposed by the Argentinean Federation. Countries should be strongly encouraged to do this on a national basis.

15 Inflation and deflation only affect the real value of monetary items not inflation-adjusted and not deflation-adjusted, respectively, on a daily basis in terms of a Daily CPI.

16 The stable measuring unit assumption affects the real value of only constant real value non-monetary items not maintained constant daily by means of measurement in units of constant purchasing power in terms of a Daily CPI at all levels of inflation and deflation.

17 The terms ‘restatement’, ‘restated’, ‘inflation restatements’ and ‘inflation-adjustment of financial statements’ are not be used in the proposed new IFRS.

18 The proposed new IFRS is a departure from Historical Cost Accounting at all levels of inflation and deflation.

Nicolaas Smith

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